Edited version of your private ruling

Authorisation Number: 1012482951648

Ruling

Subject: Assessability of compensation payments

Question 1

Are the compensation payments you receive in respect of activities on your property, as specified in various Conduct and Compensation Agreements, ordinary income?

Answer

No.

Question 2

Are the compensation payments you receive in respect of activities on your property, as specified in various Conduct and Compensation Agreements, statutory income?

Answer

No.

This ruling applies for the following periods

1 July 2012 - 30 June 2013,

1 July 2013 - 30 June 2014, and

1 July 2014 - 30 June 2015.

The scheme commenced on

The scheme has commenced.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are a partnership which owns a property. You commenced production on your property prior to 19 September 1985.

An entity has undertaken a large scale operation on your property.

As a consequence of the activity on your property by the entity, you have incurred substantial damage and a reduction in the value of your property. In addition to the permanent damage to your property, you have also suffered a loss of exclusive possession and quiet enjoyment of your property, due to the negative impacts of:

· excessive noise which can occur on a 24 hour per day basis

· light

· dust

· odour

· vibration

· vehicular movement, and

· general amenity.

You have entered into a number of agreements with the entity.

Under the terms of each agreement, payments in respect of compensation to you were based on

(a) deprivation of the possession of the land;

(b) damage to the surface of the land;

(c) severance of the land from your other land;

(d) surface rights of way;

(e) diminution of the value of the land, and;

(f) consequential damages.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-1(1)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 995-1(1).

Reasons for decision

Question 1

Are the compensation payments you receive in respect of activities on your property, as specified in various Conduct and Compensation Agreements, ordinary income?

Detailed reasoning

You have entered into various contracts with an entity which has commenced large scale operations on your property. As a result of the operations on your land, you receive compensation payments from the entity.

Under the terms of each contract you received an upfront payment, together with annual payments, as compensation for the negative impacts of the operation conducted on your land. The compensation is paid to you in respect of the following:

· the large scale operation

· numerous activities

· earthworks and extensive infrastructure installation

· substantial permanent damage to your property

· reduction in the value of your property

· loss of exclusive possession

· loss of quiet enjoyment, and

· the negative impact of excessive noise, light, dust odour, vibration vehicular movement and loss of general amenity.

Additional compensation, separate from that provided under the terms of the contracts for the disruption caused by the operation and diminution of your land, can also be claimed in the event that there is any crop loss or damage, or in the event that there are additional costs relating to your livestock. This Private Ruling only considers the compensation paid to you in respect of the negative impacts on your land, and not the circumstances where compensation is paid for crop loss or damage, or costs relating to livestock.

Are the compensation payments you have received, ordinary income?

Division 6 of the Income Tax Assessment Act 1997 (ITAA 1997), considers assessable income, and states at subsection 6-1(1):

Assessable income consists of ordinary income and statutory income.

Ordinary income is considered at section 6-5 of the ITAA 1997, and states that:

6-5(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Note:

Some of the provisions about assessable income listed in section 10-5 may affect the treatment of ordinary income.

6-5(2) If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year …

Therefore, the assessable income of an entity includes income according to ordinary concepts (ordinary income).

Assessable income according to ordinary concepts was considered in ATO Interpretative Decision ATO ID 2003/707 Income tax Assessability of an undissected lump sum workers compensation payment (ATO ID 2003/707).

ATO ID 2003/707 concluded that:

· ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business, and

· a compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Guidelines on the treatment of compensation for taxation purposes are provided in Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? (TD 93/58).

TD 93/58 states at paragraph 1 that:

1. It is assessable income under subsection 25(1) of the Income Tax Assessment Act 1936 (ITAA):

(a) if the payment is compensation for loss of income only e.g. past year profits, and/or interest (even when the basis of the calculation of the lump sum cannot be determined); or

(b) to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature [cf. Mc Laurin v. FC of T (1961) 104 CLR 381; (1961) 8 AITR 180 and Allsop v. FC of T (1965) 113 CLR 341; (1965) 9 AITR 724].

Subparagraph 1(a) of TD 93/58 concludes that only compensation with an income character forms assessable income, and is explained in paragraph 3 as:

3. In the circumstances of paragraph 1 (a) there is a receipt of income only, that is, there is no capital component in the payment. It is therefore not relevant that the basis of the calculation of the lump sum cannot be determined.

Where the character of the compensation is made up of separate amounts paid in respect of income and capital, paragraph 4 of TD 93/58 concludes that only the income portion is assessable. Paragraph 4 of TD 93/58 states that:

4. In the circumstances of paragraph 1 (b) there is included in the lump sum a receipt of a capital nature, but the `ingredients' of the payment can be identified, and therefore the portion of the payment which relates to income is assessable.

Therefore, where the compensation paid to you is capital in nature, it will not form part of your assessable income, and will be excluded from your ordinary income.

Are the amounts you receive as compensation, capital in nature?

Under the terms of the agreements that you have entered, the compensation is paid for the deprivation of possession of your land, the diminution in the value of the land, and consequential damages arising from activities taking place on your land.

The compensation to you is therefore not income from rendering personal services, income from property or income from carrying on a business, which would be ordinary income as detailed in ATO ID 2003/707. The compensation is in respect of a reduction in your capital base, and therefore has the character of capital.

As the amounts paid to you as compensation for the damage to your land are of a capital nature, the amounts are not assessable income under section 6-5 of the ITAA 1997.

Since the compensation payments you receive in respect of damage to your land, as specified in each of the various Agreements, are not assessable income, they are therefore not ordinary income.

Does the timing of the compensation payments affect the nature of the income?

Under the terms of the agreements that you have entered, you will receive compensation in two parts:

· an up-front payment, and

· annual payments.

The regularity of compensation payments was considered in Coward v FC of T 99 ATC 2166; (1999) 41 ATR 1138 (Coward's Case), where the applicant opted for a lump sum payment in redemption of an entitlement to receive weekly payments of compensation.

Considering the timing of the payments, the President of the Administrative Appeals Tribunal, Mathews J, said at 2172 in Coward's Case:

32. His Honour then proceeded to consider whether compensation payments, calculated as weekly payments and paid regularly, took the character of income by virtue of their periodicity. On this question the AAT had found that periodicity of payments alone was not sufficient to convert capital payments to income.

Mathews J continued in Cowards Case at 2173, where he said:

33. … Periodicity of payment alone may not be determinative of the question of whether the payments are in the nature of income but such a circumstance is important and additional circumstances may make it clear that the periodical payments do have such a character …

In Cowards Case, Mathews J then refers to "the basic rule" established in Tinkler v FC of T 79 ATC 4641; (1979) 10 ATR 411 that:

… payments to compensate for lost income are themselves income …

In your case, the compensation is paid for the deprivation of possession of your land, the diminution in the value of the land, and consequential damages arising from activities taking place on your land.

As established above, your compensation has the character of capital, and the payments, as detailed in Coward's Case, irrespective of their periodicity, will remain capital. The timing of the compensation payments will therefore not affect the nature of the payments.

Question 2

Are the compensation payments you receive in respect of activities on your property, as specified in various Conduct and Compensation Agreements, statutory income?

Detailed reasoning

Statutory income is considered at section 6-10 of the ITAA 1997, which states:

SECTION 6-10 Other assessable income (statutory income)

6-10(1) Your assessable income also includes some amounts that are not ordinary income.

Note:

These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5.

6-10(2) Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.

Note 1:

Although an amount is statutory income because it has been included in assessable income under a provision of this Act, it may be made exempt income or non-assessable non-exempt income under another provision: see sections 6-20 and 6-23.

Note 2:

Many provisions in the summary list in section 10-5 contain rules about ordinary income. These rules do not change its character as ordinary income.

…

Under subsection 6-10(2) of the ITAA 1997, any assessable income received in the form of compensation that is not ordinary income, is called statutory income.

However, as detailed above, the income that you receive as compensation for paid for the deprivation of possession of your land, the diminution in the value of the land, and consequential damages arising from activities taking place on your land, are in the nature of capital, and do not form part of your assessable income.

As the income from compensation does not form part of your assessable income, it is excluded from your statutory income in section 6-10 of the ITAA 1997.

Since the compensation payments you receive in respect of damage to your land, as specified in each of the various Agreements, are not assessable income, they are therefore not statutory income.

Does a liability to Capital Gains Tax arise on the compensation receipts?

Capital Gains Tax (CGT) applies from 20 September 1985, and you acquired your property prior to 19 September 1985.

Guidelines on the application of CGT where a person receives an amount as compensation, is provided in Taxation Ruling TR 95/35 Income Tax: capital gains: treatment of compensation receipts (TR 95/35).

Key terms are defined in paragraph 3 of TR 95/35, and the term 'underlying asset' is defined as:

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

Paragraph 5 of TR 95/35 details the treatment of pre-CGT underlying assets, and states:

5. It follows that if the underlying asset disposed of was acquired by the taxpayer before 20 September 1985, the receipt of the compensation has no CGT consequences for the taxpayer. Refer to Example 2 in this Ruling …

Example 2 in TR 95/35 reinforces the absence of any CGT consequences in receiving compensation for a pre-CGT underlying asset. Example 2 states:

Example 2

264. Avery Landowner owns a large tract of land at Burn Creek, which he acquired in 1962. In July 1991, the Commonwealth compulsorily acquired 32 hectares of the land under the Lands Acquisition Act 1989. In accordance with the Act, Avery was entitled to receive compensation for the compulsory acquisition. The Commonwealth valued the land at $600,000, 90% of which was advanced to Avery at the time of the acquisition, pending final determination of the value.

265.

Applying Example 2 to the facts surrounding the compensation you receive in respect of the diminution of your pre-CGT underlying asset, a liability to CGT does not arise.